WWII 063: Charlie Munger Mental Model Auto-Catalysis, When to Sell A Poor Performer, Elliot Associates Influences $ARNC

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Main Topic: Charlie Munger's Mental Model from Chemistry: Auto-Catalysis

This episode is about another of Charlie Munger’s mental models that he uses as a decision-making framework. I introduced the concept of these models in episode 54 and then did an episode on the mental model of permutations and combinations in episode 55.

The Auto-Catalysis mental model comes out of the discipline of chemistry.

Here’s a definition of auto-catalysis from Wikipedia. A single chemical reaction is said to have undergone autocatalysis if one of the reaction products is also a reactant and therefore a catalyst in the same or a coupled reaction.

So the initial reaction creates a by-product, which is a catalyst for the initial reaction, continuing the process. Think of a chain reaction. Once you get it started, it continues and can’t be stopped.

A physical example would be a room full of mousetraps loaded with ping-pong balls. Toss one ball into the room starts a chain reaction that accelerates rapidly until all the mousetraps have been set off. (LOOK FOR A VIDEO).

Let’s see if can spot auto-catalysis like qualities in some companies.

One of my favorite examples of auto-catalysis in business is Disney. Walt Disney in the 1928 started producing cartoons on physical reel to reel film which was invented in 1891. Once those films were made, the hard work was done. Eventually, new media was created, the videotape in 1958, and the Video Home System or VHS in 1976, and the Compact Disc or CD in 1983, and Blue-Ray Disc in 2003.

So the initial reaction, in Disney’s case, is the creation of the catalog of movies. This catalog sat there and each time a new media would be created, Disney would simply transfer its catalog onto the new media, and boom, instant growth in sales. Auto-catalysis in action. Disney didn’t have to invent it, or need to create a new product to get an instant and large increase in revenue.

How about a less “healthy and fun” industry…tobacco. Tobacco has been one of the most profitable businesses in the history of the world, and has enriched shareholders along the way. Once you smoke a few cigarettes, the initial reaction, you become hooked on nicotine and become your own catalyst. You will represent thirty or forty years of constant and steady sales for the tobacco industry until cancer kills you. These are facts, people, not opinions.

The whole purpose behind learning and incorporating mental models in your mind is to be able to apply these mental models to your investing process. Would you have recognized the auto-catalysis of Disney or the tobacco industry if I hadn’t brought it up?

The reality is that there are not many companies that benefit from auto-catalysis, and the ones that do are not priced attractively very often. However, once you have found one, you can put it on your “Buy” list at a price that you would be willing to pay for it and maybe, just maybe, in the next big market crash, you will have enough cash to finally buy yourself some auto-catalysis for your portfolio.

Ask JB: When should I Sell? What would trigger you to sell?

When do you decide to sell a stock that's performing poorly? (self.investing)

submitted 9 hours ago * by Summzashi

Edit: As in, a stock that caused you to lose money.

JB Says: The rule I have is I give an idea one to three years to start working, to show the underlying performance that I estimate is there. As a value-based investor, I’m most likely to buy into a value-trap. Each year it doesn’t work, I’ll re-visit the thesis and compare it to reality to see if there is a problem. If not, I keep it. You can own something for four years with no return, have it double in year five, and end up with 15% compounded returns.

If the market overall has had a poor performance, it may not be the company fundamentals that are causing it and may actually be an opportunity to buy more.

That being said, if a position falls more than fifteen percent it becomes a candidate for a position reduction and I really tighten the scrutiny on it.

Ask JB: [–]LemonFreshenedBorax 2 points 1 day ago*

What is the maximum percentage of your net worth you would devote to a single 'angel investor'-type project?

I realize there is no hard-and-fast rule for this, I'm just wondering what people's preferences are. A person whose work I've been following since the 90s just had his kickstarter fail. I am deeply disappointed by this and was thinking of getting in touch with him and working something out privately. I realize that 'failed kickstarter' can mean 'unmarketable product' but based on my (admittedly highly informal) market research I don't think it means that in this case. Can I afford to lose the money? I'd survive without it, but I'd feel really stupid. Stupid enough to make the whole thing not seem worth it? That's harder to say. With regard to the boilerplate questions: I'm 33, debt-free, house is paid off, and my girlfriend and I's combined income is slightly above average for this area.

JB Says: Investing in early stage start-up companies should be left to experienced business people. If you are worried about feeling stupid, your gut instinct is telling you that you are about to put money into something you don’t understand. You should fully understand whatever you put money into. Don’t be ok with losing money. Learn to hate it.

Do you have a burning question on investing you would like answered? Click the button below to send it to me and I will answer it on the podcast!

Activist Investor Action  Alert in the stock of Arconic ($ARNC)

Elliot Associates has taken a large position in Arconic stock and is attempting to get a slate of directors elected.


Thoughts on this podcast? Disagree with me on some point? Something I missed? Leave a comment!

About the Author

Jeremy Scott Bailey is an investor, author, entrepreneur and host of the "What Works In Investing?" podcast now available on iTunes. He is founder and Chief Investment Officer of Burgeón Group, Inc. an investment advisory firm that provides portfolio management services to families and individuals.

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